Sunday, October 24, 2010

Rothbard on Fractional Reserve Banking: A Critique

By Michael S. Rozeff
The Independent Review, Volume 14, Number 4
Spring 2010

From the Abstract: Murray Rothbard, in The Case for a 100 Percent Gold Dollar (1974), maintains that fractional-reserve banking is fraudulent and inherently destabilizing of the economy. However, by considering how a regime of laissez faire in money and banking might operate, we may reach a judgment quite different from Rothbard’s.

Rozeff writes:

"Murray Rothbard, in The Case for a 100 Percent Gold Dollar (1974), maintains that fractional-reserve banking is fraudulent. Viewing it as coercive and unlawful, he argues that banks ought to be allowed to serve only as warehouses for money. He insists that all deposits become bailments, not debts or credits. Money would always be an asset, never a liability. A proper bank would, in his view and by law, hold all deposits intact and become a 100 percent reserve-storage or safety-deposit bank, although to call such a business a bank under these conditions is something of a misnomer because such a so-called bank makes no loans.

Rothbard’s firm belief that fractional-reserve banking constitutes fraud rules out fractional-reserve free banking even in a free market. This position, I argue, goes against basic ideas of liberty and the free market, both of which Rothbard champions. When he regards fractional-reserve banking as fraudulent and proposes its illegality, he introduces his own ethical judgment based on his own assessment of the merits of any and all exchange transactions that may occur between banker and depositor. He introduces his own idea of the appropriate property rights in a bank deposit, his own idea of what appropriate money must be, and his own idea of libertarian law. Although he is entitled to his opinions, the market participants in a condition of liberty in free markets decide all these matters for themselves, and their reasoning and valuations may differ from Rothbard’s. They may not regard fractional-reserve banking as fraudulent, and they may want to transact via fractional-reserve banking arrangements. They may wish to circulate media of exchange that are someone else’s liabilities.

Rothbard’s position has since been espoused in books by both Jesus Huerta de Soto (2001) and Jorg Guido Hulsmann (2008) as well as in articles, such as one by Hans-Hermann Hoppe, Hulsmann, and Walter Block (1998) that argues against fiduciary media. These latter-day adherents to Rothbard’s position show no diminution in the strength of their convictions, despite the criticisms presented by George Selgin and Lawrence H. White (1996), who have argued against Rothbard’s position and supported free banking. For example, Hulsmann writes in his book, “There is no tenable economic, legal, moral, or spiritual rationale that could be adduced in justification of paper money and fractional-reserve banking” (2008, 238). This extraordinary statement boldly restates Rothbard’s beliefs. If a community willingly and freely uses paper money, shall Hulsmann maintain that they have no rationale? Moreover, it is not difficult to locate scholarship that provides viable economic reasons for paper money and fractional-reserve banking. It is quite easy to find numerous real-world instances in which paper money, tokens, scrip, and credits arose spontaneously (see Timberlake 1987). I argue here that the Rothbardians have not proven, either on grounds of morality or on grounds of economics, that paper money or fractional reserve banking evinces criminal behavior.

Monetary Freedom - Instead of arguing, as Rothbard does, that monetary freedom necessarily requires 100-percent-reserve banking, let us ask what monetary freedom might look like. The institutions and practices that arise under freedom are impossible to know in advance. We can imagine many possibilities. People themselves decide what kinds of property rights they want and find acceptable in bank accounts. They hammer out what is fraudulent and what is not. Banks and their customers decide the details of their own exchanges. People decide what value standards (units of account) to use to establish prices and what media they want to use as money, whether commodity, paper, electronic, or something else. People may demand bank audits as they see fit, and they may become part of the market structure. Banks may issue their own banknotes. Perhaps banks arrange central clearing houses that issue notes. Retail establishments may become involved in issuing various clearing certificates. Local clearing systems may arise that use credit clearing. People trade and use banknotes as money if they wish. They depreciate those currencies that they believe are losing value, and they flock to the media that they think may appreciate or hold their value. If media are convertible, people decide on the appropriate media of redemption."

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